A legislative provision that would have increased payroll taxes for small businesses filing as S corporations—including many architecture firms—was eliminated from a bill that sought to boost job creation, close tax loopholes, ensure corporate accountability, and extend unemployment insurance and health benefits.
The "American Jobs and Closing Tax Loopholes Act of 2010,", which has failed to pass in the U.S. Senate several times, has gone through numerous permutations. Most recently, the section addressing professional service S corporation payroll taxes was dropped in an effort to advance the bill.
Intended to close a tax loophole in which S corp. owners avoid payroll taxes by drawing a nominal salary and collecting the rest of the firm's profits through a dividend, the provision was opposed by the American Institute of Architects (AIA), which lobbied against it on behalf of its members. The provision would have treated the earnings of professional service S corps. in which 80 percent or more of the business' gross income is attributable to the service of three or fewer shareholders or owners as income subject to payroll taxes.
According to the AIA, many architects have formed or are working for S corps. out of necessity as a way to gain financial flexibility or protection against liability or bankruptcy as they start their own firms during the recession, among other reasons. A large concentration of residential architects file as S corps, according to the AIA.
"The money leftover after all expenses and salaries—after you pay yourself [as an S corp. owner], your employees, and payroll taxes—the part that would have been taxed under this provision—that's the money that firms reinvest in themselves; to purchase technology or hire more staff," says Andrew Goldberg, senior director of AIA federal relations. "Firms pay taxes on those profits. To tax it as salary doesn't make sense and it becomes a disincentive to reinvest in the firm and more incentive for principals to take higher salaries."
"The provision was couched as closing a loophole, and there are certainly some people who are taking advantage of the system," Goldberg adds. "But the IRS already has procedures in place to go after those people. This would have impacted a lot of small companies that are playing by the letter and spirit of the law."
Moreover, the S corp. provision arbitrarily focused on firms with three or fewer principals regardless of the number of employees, and used vague language that would have made determining whether the provision pertains to a particular firm extremely difficult. The AIA took issue with the provision's focus on small businesses in which the "principal asset" is the "reputation and skill" of three or fewer owners because it failed to define "skills," "reputation," and "assets"—things that are difficult to quantify and value. "It becomes a disincentive for people to stay in a profession," Goldberg says.
On July 21, the Senate passed a pared-down substitution for the original bill, known as the "Unemployment Compensation Extension Act," which retroactively restores expiring emergency unemployment benefits and extends them through November 2010, among other provisions. It was then passed by the House of Representatives and signed by President Barack Obama on July 22.
Goldberg notes that while the S corp. payroll tax increase provision has been removed from the original bill, it potentially could be added to any other bill the House and Senate may consider.